In the wake of new compliance rules, activist shareholders and the after-effects of corporate scandals, a great deal has been written lately about the quality of corporate boards. What should be their composition and focus?

In fact, a large consulting industry has emerged to advise and educate board members and assist in almost every phase of their work, from audit and financial management to member selection. Still, there is no cookbook approach for any of the topics, options or tools available to boards.

It is important to understand how different types of boards function and how a board’s very structure and development can affect a company’s management. In the end, the biggest question is how boards can evaluate and select new members to create high performance that best serves their organizations.

Advisory vs. compliance

What type of board does the company already have and how does it function? Should it be altered? There are predominantly two types of boards today: the traditional board and the professional board. The traditional one is sometimes called a guidance or advisory board while the professional one is known as a compliance board.

Tom Perkins, the former Hewlett Packard director who was at odds with the lead director and management, spoke about what he calls the compliance board in a recent Wall Street Journal article. Perkins disparages boards comprised of what he calls professional directors focused on compliance issues, and he calls for boards comprised of people from the industry who can act as effective management advisors and provide a strategic outlook.

Of course, both types of members can be on a board and, in fact, what he describes as an advisor may be someone with deep industry experience, as well as experience with and an interest in compliance issues. As might be expected, Carly Fiorina, the then-chief executive of HP, saw the issue as not with the type of board, but rather, as with a very difficult situation with the board. The difficulties included a polarized board, breaches of director fiduciary responsibility, the board’s relationship with the CEO, and the role of the board versus the role of management.

While it is much more likely that a board in today’s business environment will be somewhere between these two extremes, it may behave in one of several characteristic ways. In his May 2004 Harvard Business Review article, David Nadler discussed the five predominant behaviors that characterize boards.

The passive board functions at the behest of the CEO (who is also likely the board chairman), generally agrees with management, and has limited discussion and activity. Members move in a close social circle with the CEO and typically are chosen by him or her. Such boards have several members classified as inside directors and fewer members classified as independent. The appearance of independence may be maintained but, in truth, they are not independent in either thought or behavior.

The certifying board certifies to shareholders and external constituents that management is following board direction, has predominately independent directors, follows recommended governance guidelines, stays well informed and ensures an orderly succession process. It will replace the CEO if it feels expectations are not being met.

This last point is perhaps the defining difference for this type of board compared with a passive board. Although there is an orderly process for selecting new members, wide searches for members are not common, especially searches that are facilitated and assisted by an outside consultant.

The engaged board provides advice and counsel to the CEO and management and sees its role as one of oversight. Generally, there are beneficial discussions of critical issues and a clear understanding of board responsibilities and processes, especially those dealing with committee structure and responsibilities.

These types of boards tend to function independently but in concert with management. Often, they call in external advisors for especially difficult operational, financial or legal issues. Great effort is made to perform within governance guidelines, especially with regard to CEO performance evaluation, executive compensation and board performance.

Virtually all engaged boards have a lead director who chairs meetings of independent directors and works with the CEO to determine the board agenda. They may have a non-executive chairman who is responsible for the board agenda and board processes when the duties of the CEO and chairman are separated.

The intervening board becomes strongly involved in decision-making, meets often and is characterized by intense discussions, which may result in widely differing opinions about the company’s strategic direction. Its experienced members regularly inject themselves into operational issues.

In some instances, company boards in a crisis situation behave in this manner, and are typically comprised of independent or classified members who may or may not agree with the direction of the company.

As with engaged boards, the intervening board is organized with a majority of independent directors, has a lead director and follows governance guidelines. However, because it is intervening, the roles of management and the board are blurred.

The operating board is the most proactive; it makes operating decisions that management implements. This type of board actually takes over management responsibilities and usually exists when a company is seriously underperforming or in legal or regulatory difficulty. Operating boards have often replaced key managers. The same board may function as an engaged or intervening board when the external or internal difficulties ease.

Typically, this board type has a very strong lead director or non-executive chairman. There may also be widely varying opinions about the strategic direction of the company, since it is usually under duress at this point, so the board becomes Balkanized.

Board membership

The membership of a board determines how it functions and how effective it is in governing the company. For example, if a board has strong independent members, it is likely classified as an engaged or, at times, an intervening board. Such a board may function as an advisory (traditional) board or, depending on membership, as a primarily compliance (professional) board.

The compliance board may have several people with legal or accounting backgrounds whose orientation and interests differ from someone who has long operational experience and interest in a specific industry, such as energy. The key question becomes how the traditional role of an advisor, while meeting the new role of ensuring compliance, can be sustained.

Crafting such a board clearly is a challenge, especially considering recent trends in board membership in the context of court, litigation and governmental activity; the emergence of active and aggressive stockholders; and the focus on short-term rather than long-term financial results.

Recent research can offer guidance for developing such a board. Board size, member tenure and age, member experience, relative power (CEO versus the board), CEO evaluation process and tenure, member selection and board independence were reviewed for 3,000 organizations. The study supports that smaller boards influence strategy more than larger boards; higher-tenure boards affect strategy more than low-tenure boards; diversity of business experience and demography affects the board’s role in strategy; and strong boards lead to greater strategic focus and company performance.

Evaluating the board

An assessment conducted every year helps ensure the board has the desired structure, characteristics and processes to provide the oversight needed. Directors perform different roles on the board and each role is associated with different levels of involvement and expectations. Failure to perform can result in serious issues for the company and its board, and may be good cause to end a member’s board service.

Unfortunately, some companies don’t learn until there is a crisis that a board is operating without the right leadership or skillset. Or, a board may conduct internal evaluations that simply don’t dig deep enough to discover insight into its function and future development needs.

Gone are the days when the “tick the box” assessment can reveal results necessary to properly evaluate overall board performance, individual contributions of directors and how they might interact on a personal and professional level with other board members and management.

As part of an effective governance program, responsible companies must establish processes to allow routine board evaluations by peers, a qualified third-party, or director self-evaluation. With the right process, regular and accountable assessment can measure overall board performance and individual directors’ contributions.

According to a report by the National Association of Corporate Directors, there are six key process elements for the success of a board and director assessment.

These include: ensuring independent director control; establishing evaluation processes and goals; tailoring evaluations to the company and to the board; ensuring candor, confidentiality and trust; regularly reviewing the evaluation process; and disclosing to shareholders assessment procedures and criteria.

Furthermore, it is essential to understand what boards are authorized to do and what type of board function exists (traditional versus professional) before embarking on an evaluation of the board’s effectiveness.

Selecting directors

Corporate boards are beginning to recognize the need to conduct board searches differently. It is no longer enough to determine the voids in skillsets and recruit to fill those voids by running a database of qualified individuals. In fact, dozens of outside consulting firms offer board evaluations using a skills matrix to determine professional and personal characteristics.

The matrix is designed to determine what is there and what is missing. Is it enough to know the director’s industry knowledge, public-company experience and management acumen, as well as integrity, judgment, financial literacy, confidence and performance standards?

The piece that is often missing is how to recruit directors who add value, based on the professional and personal skills they bring to the table. To better understand this missing link, the board must be willing to allow a thorough evaluation, including group and individual discussions with the nominating committee or an outside consultant, to better define qualifications for board positions.

A good recruiter will consider the needs of the board and those of the company it serves, much like a marriage matchmaker investigates the background of the family and the individual before recommending a relationship. This level of recruiting cannot be achieved by running a database of names.

Board members and company executives need to be year-round recruiters. Using an ongoing process, potential candidates can be identified and moved into “the pipeline” to be examined more closely when the time arises. In this best-practices scenario, it becomes the responsibility of every board member to pass along contact information to the selection committee and its search firm.

The best boards function as partners with management and the CEO. It is possible to recruit “value-added” directors when their selection is based on evaluation of existing board skills and determining the desired skillset of new members.

An essential part of this process is analyzing the board’s structure (passive, certifying, engaged, intervening or operating) and engaging experienced and knowledgeable professionals, either on the nominating committee or outside consultants, to facilitate the evaluation and search process.

By paying attention to board types, membership traits and focus, it is possible to achieve peak performance for the board, its members and the company it serves.

Thomas D. Clark Jr. is president of Strategy Associates, a management-consulting firm that specializes in strategy planning and development, and corporate board governance assistance. He currently serves on the boards of Dynegy Inc. and Endeavour International Corp. David E. Preng is founder and president of Preng & Associates, an energy-professional search firm specializing in international recruiting for board director and senior-level assignments. He serves on the boards of Cal Dive International, BPI Energy Holdings and Community National Bank.

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